China rule change sets stage for fund upsurge

Hong Kong seen as likely beneficiary of foreign investment relaxation

ChrisOliver

HONG KONG (MarketWatch) -- Chinese securities regulators may well have been keeping one eye on the calendar as the 10-year anniversary of Hong Kong's return to Chinese sovereignty approaches.

Analysts said Beijing's Wednesday announcement that securities firms and mutual funds have been added to the list of financial institutions allowed to channel clients' funds into overseas markets may be timed to coincide with the upcoming Handover anniversary on July 1.

'The message basically is that more money will be allowed out of China than previously expected and it will be spread through more hands.'
Howard Gorges, South China Brokerage

"As we expected, a series of measures and announcements have been made to push the Hong Kong stock market higher," wrote Steven Sun, regional equity strategist HSBC, in a research note Thursday.

The Chinese Securities Regulatory Commission said Wednesday that domestic brokerages that have at least 800 million yuan ($105 million) under management and mutual funds of 200 million yuan in size will be allowed to invested in stocks and other structured products on overseas markets under the government's qualified domestic institutional investor program, or QDII.

The brokerages and funds must also have been established for two years and meet other qualifying criteria.

Under the new rules that take effect July 5, mainland investors working through these institutions can buy a wider range of investment products -- stocks, bonds, American depositary receipts, real-estate investment trusts, financial derivatives, and asset-backed securities -- traded abroad.

However, investments in property, precious metals, commodities for physical delivery and shorting of securities remain off limits.

The changes will enable fund houses and brokerages to offer yuan-denominated funds, rather than just foreign-currency funds. The change could make investing overseas more appealing for some mainland investors who believe the yuan will continue to appreciate.

"The message basically is that more money will be allowed out of China than previously expected and it will be spread through more hands," said Howard Gorges, vice chairman South China Brokerage in Hong Kong.

Significant inflows could be months away, according to analysts.

"This is fairly typical of mainland behavior, they want to try and create a good atmosphere," Gorges said, noting that "June and July are quite sensitive." The anniversary of the Tiananmen Square uprising was marked on June 4.

'Absolute no-brainer'

Analysts also said encouraging excess liquidity to flow into Hong Kong would help tamp down China's overheating stock and real-estate markets, while at the same time helping to shore up asset prices in the former British territory.

Hong Kong's shares rallied to another record Thursday, buoyed by expectations mainland fund flows would underpin share prices and help close the valuation gap between shares listed in Hong Kong and those listed in Shanghai and Shenzhen, analysts said.

The H-share index, a gauge of 41 Hong Kong-listed companies incorporated on the mainland, climbed 2.5%, also setting a record at 12,207.97.

"The sentiment created by the prospect of QDII is obviously what is driving Hong Kong," Cavey said.

Hong Kong's H-share index trades at about 19.2 times projected 2007 earnings, while comparable shares listed in Shanghai trade at a multiple of about 45 times.

About $17 billion has been allocated for overseas investments in bonds and equities under current QDII rules, but HSBC estimates the plan could eventually see $400 billion in Chinese capital enter global financial markets.

Wednesday's amendments to the scheme made no mention of changes to the investment cap.

"Its not like you hear the announcement today and tomorrow the money will flood in," said Dong Tao, chief regional economist for non-Japan Asia at Credit Suisse in Hong Kong.

Tao said large fund flows out of China would not been seen until early next year owing to delays in establishing administration and custodial procedures.

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